The Breakdown - The Macro Battle That Will Shape Crypto Markets This Year

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io, Abra, and FTX, and produced and distributed by CoinDesk. What's going on, guys? It is Monday, January 10th, and today we are talking about the macro battle that will shape crypto markets for the rest of this year at least. Before then, however, if you are enjoying the breakdown, please subscribe to it, rate it, review it, or if you want to get deeper into conversation, join the breakers Discord. The link is in the show notes, or you can find it at bit.ly slash breakdown pod. And as always, a disclosure, in addition to them being a sponsor,

Starting point is 00:00:55 I also work with FTX. So, last week on the episode about why Bitcoin and crypto were crashing, I basically said that it was the Fed. specifically, it was the Fed FMC meeting minutes coming out showing that not only was the Fed going to be hiking rates this year, something that we found out about last month. But they were already talking about balance sheet normalization, or to use a different word that they were clearly trying to get away from, quantitative tightening. That is, if quantitative easing is putting liquidity into the system, quantitative tightening is the opposite, removing liquidity from the system. This has some folks out there feeling like we are in the midst of a fundamental shift

Starting point is 00:01:40 in the conditions that have driven markets for the last several years, extending back even before all of the post-COVID policies. Those folks tend to believe that this means that risk assets, which include crypto at this point from the lens of equity investors, are in for a tough time as such a key underlying factor in the market shifts. Others disagree with that thesis and don't believe that rate hikes and all these changes are a particularly large risk factor for crypto. However, on top of all of that, there's also a larger conversation happening at the highest levels of government, which is in a fundamental way how the government should respond to what's happening right now, in particular inflation. Will we go full-bore austerity, saying it's worth

Starting point is 00:02:24 a recession, for example, to get inflation under control? Or will we head in the opposite direction? At the end of last week, a Biden speech gave some insight onto that, and I believe that this will be one of the most salient and important debates shaping the politics of the midterm elections in the U.S. this year. Now, why is this worth a whole show right now? Well, last week when we talked, it was just first impressions. People were giving their first hot takes on what the minutes mean, and obviously the markets were in the midst of starting to go risk off. Now we've had a week. Tweets have become threads. Drawdowns have become more pronounced. And the president, making speeches about the situation, so it's just sort of fundamentally different. To kick this off, I'm going to read one of the rare threads from Alex Kruger. It gives both a recap of what's been happening, as well as an analysis of what it means for digital assets. There has been a very

Starting point is 00:03:19 fundamental shift at the Federal Reserve. The Fed has flipped decidedly hawkish. Their main worry is not employment, it is inflation. And to fight inflation, the Fed has to increase interest rates. Here's a threat about the Fed and crashing markets. It all started with Powell's inflation no longer transitory comment of November 30th, and culminated with the FMC minutes released on Wednesday, where Fed officials discussed faster balance sheet normalization. The latter is worrisome enough to trigger a bare market. This has been extraordinarily bearish due to the speed of the Fed's turnaround.

Starting point is 00:03:52 Raising rates or tapering quantitative easing should not be bearish enough to change the upwind trends across assets, but this goes beyond that. This is a matter of how fast the Fed flipped hawkish, and a matter of potential accelerated balance sheet normalization. Here's the Fed's chronology. June FOMC expecting no rate hikes for 2022. September FOMC, expecting half a hike, median estimate for 2022, and announcing QE tapering would start soon.

Starting point is 00:04:19 November FOMC announcing slow QE tapering. December FOMC expecting three hikes plus accelerated QE tapering. December FOMC became no notice. in the minutes released this week, discussing accelerated balance sheet normalization for 2022. So in less than six months, the Fed went from expecting no rate hikes for 2022, party goes on, to expecting three rate hikes, accelerated taper, and discussing accelerated balance sheet normalization. Balance sheet normalization was not on anyone's radar for a long time. Not only is this now a possibility in the near term, but also the Fed is talking about doing so faster than in 2018. That's why

Starting point is 00:04:59 crypto assets dropped 15 to 30% in two days last week. Accelerated normalization would be dreadfully bearish. What does balance sheet normalization mean? It means reversing the asset purchases conducted under QE. This is also known as quantitative tightening. The Fed has been adding $120 billion a month via QE since the corona crash. Accelerated QT would mean doing the opposite at more than $50 billion a month. 50 was the size of QT in 2018, say $80 billion. Under that scenario, the Fed goes from pumping an additional $120 billion into the economy to subtracting $80 billion from the economy, a $200 billion per month difference. How does that matter for crypto? Simple. Crypto assets are the furthest end of the risk curve. Just as they benefited from extraordinarily

Starting point is 00:05:46 lax monetary policy, they suffer from unexpectedly tight monetary policy as money shifts away into safer asset classes. Furthermore, Bitcoin is now a macro asset that trades as a proxy for liquidity conditions. As liquidity diminishes, macro players now in the fray sell Bitcoin, and all of crypto follows. Crypto correlations with Bitcoin dropping anytime soon are a pipe dream. Let's put this in shitcoin terms. What happens when defy projects increase yields via increased supply? Prices go down. And what happens when projects burn supply?

Starting point is 00:06:18 Prices go up. The Fed is here your shit coin master in chief, and the U.S. dollar is the king shitcoin. As the Fed goes from increasing supply, the size of its balance sheets, to burning supply, the U.S. dollar starts going up, and everything else goes down vis-a-vis the dollar. So, what now? Crypto assets have already dropped dramatically. Bitcoin is already down 40% from all-time highs, ETH is down 30%. Prices are oversold and holding at major support. Yet funding has not turned extremely negative. I'm thinking as follows. Number one, bounce next couple of days. Number two, up or down depending on Wednesday's inflation data. Number three, stay

Starting point is 00:06:54 offensive into the end of Q1. Number four, buy in May and go away? Impossible to anticipate when the time to turn full bull will be, have to be patient. Wednesday will have the U.S. inflation data. Think prices should chop around 41 and 44K until then, with an upward skew given how strong the rejection of the lows has been. If CPI surprises on the downside, expect prices to pop and trend for a while. If CPI surprises on the upside, lights out Bitcoin is going into the 30s, TradFi will make sure of it.

Starting point is 00:07:22 If the number comes in line with the forecast at 7.1%, hard to tell. Would make sense for bears to attempt to break the load. fake breakout and a rabid rally to ensue, given the chart. That said, crypto will follow Bitcoin and Bitcoin will follow stocks. TLDR so far. The Fed is saying it is willing to prick the bubble. The bear case is they do. The bull cases inflation starts to consistently surprise on the low side, and they don't need to. Inflation is everything. Inflation will eventually start heading lower. For three reasons. Tighter monetary policy, diminishing supply-side bottlenecks, dominant long-term deflationary forces. The market expects inflation to be much lower by year-end.

Starting point is 00:08:02 Question is, will inflation drop fast enough or will the Fed cuck us all? And the final question is, can crypto ignore the Fed if it decides to go all outwielding a deflationary machete? I doubt it. Don't fight the Fed applies both ways, up and down. If the Fed is too hawkish, then Houston, we have a problem. Nexto is a trusted and easy-to-use crypto platform where you can buy cryptocurrencies at the touch of a button and start earning up to 17% annual interest that is paid out daily. They support all of the major assets on the market and even allow you to swap one asset for another or borrow cash against your crypto without selling it.

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Starting point is 00:09:15 and earn interest with up to 14% APY on stablecoins and 8.15% APY on Bitcoin. Visit Abra.com or download the app from the Google Play. or Apple App Store today. Abra, Conquer Crypto. The breakdown is sponsored by FTX. FtX is the safe, regulated way to buy and sell Bitcoin and other digital assets. Trade crypto with up to 85% lower fees than top competitors.

Starting point is 00:09:44 FtXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. You can trade NFTs with no gas on FTXUS, and gas is subsidized when you withdraw off the platform. Help support the breakdown and visit you visit. at FtX.US today. That's FtX.us. As you can see, guys, great summary of what's been happening, even if you don't necessarily agree with Alex's conclusions. And of course, not everyone did. Here's Jeff Dorman at ARCA. Respect Alex a lot. Disagree with most of this. I'll be writing about it tomorrow. Preview rates rising doesn't cause bare markets. The Dixie isn't rising. Inflation will fall fast. You're over your comps hard. And correlations are absolutely falling between

Starting point is 00:10:30 Bitcoin and other digital assets. Now, Jeff hasn't put out his full, that's our Satoshi's post about this yet. I'll be sure to share any more details when it does, but he did give a preview thread. He writes, Here we go again, time to debunk macro-theces regarding the Fed rate hikes and their likely impact on digital assets and equities. Three moments showing why the Fed rate hike cycle is likely not bearish for digital assets anytime soon.

Starting point is 00:10:54 History lesson. One, the last time Hawkish Fed statements caused a market meltdown was in Q418. SPY was down 7% in October and down 9% in December. This was after two years of rate hikes from 2016 to 2018. Equities rallied during the hike period. The negative 23% taper tantrum led to the Fed lowering rates again and stocks rallied. Number two, before that, the Fed last raised rates over a two-plus year period from June 2004 to July 2006. And the equity market rallied the whole hike cycle until the end of the hiking cycle and didn't fall until mid-year.

Starting point is 00:11:30 2007, when the Fed was actually lowering rates again. Three, the two-year and 10-year treasury curve almost always flattens after the first hike by an average of 80 basis points over the next 12 months. But a recession typically occurs around 18 months after the two-year and 10-year inverts, so we're likely 30 months away from a recession. Bottom line, the Fed raising rates is not what causes big, long-lasting market sell-offs. It's after very long-fed hike cycles, when markets typically face sustained declines and recessions happen. Since there are basically only three bare cases for digital assets mostly stemming from unscientific assessments of when the money printer stops going bur,

Starting point is 00:12:07 consider me not super concerned. If digital assets fall, it's not going to be because of the Fed. Now, here are a couple more folks who are hesitant to go full bear. Dan Tapiero, friend of the show, says most bullish macro backdrop in 75 years. Booming economy supported by massive negative real rates, Fed will never equalize rates with inflation. Stay long stocks in Bitcoin and ETH huddle through short-term volatility. Real dollar cash savings will continue to lose value.

Starting point is 00:12:37 CryptoBurb tweets, Since bottoming out in the depth of 2018 depression, Bitcoin has only seen this oversold indicator four times at 3K, 10K, 4K, and 30K. Not long after these records were achieved, Bitcoin rallied 340%, 17%, 1,585%, and 141% respectively. Now, while there's some argument then about what a Fed shift will actually do in the crypto markets and in the stock market, these counterpoints aren't necessarily arguing that the Fed isn't actually shifting.

Starting point is 00:13:12 And interestingly, the part of the market that seems to be arguing and pricing in most strongly that the Fed is shifting is the bond market. Jim Bianco, who's a great macro analyst, says in some respects, what happens to the market, in bond markets last week was epic, something we might be talking about for many years. The 30-year data goes back to 1973, and last week was the worst calendar week total return in at least 49-year history. If this was a year, a 9.35% total return loss would be the five-year worst year ever, impressive for five days of work. The 10-year note finished its worst week in 42 years, with a total return loss of 4.24%. Only February 1980 saw a bigger loss for a calendar week loss.

Starting point is 00:13:53 Volcker inflation panic funds rate headed to 21%. Finally, the calendar week total return for the Bloomberg 10-year Tips Index was negative 6.09%. This marks the third worst week ever. Note above each one of the other marked weeks were significant. 31320, negative 14.39% equals peak COVID panic fed buying $100 billion a day of bonds. 91319 down negative 5.19, the week the repo market blew up. 62113, negative 5.12%, the height of the taper tantrum. 10108, negative 7.13%.

Starting point is 00:14:30 Lehman failed. Why was last week so epic? I believe the whole bond market finally realized that easy money is over and quantitative tightening is coming. For weeks, many bond players argued that easy money is over and quantitative tightening is coming. Simply put, the bond market saw one of its worst weeks in history because bond market players finally got it,

Starting point is 00:14:51 that the Fed is going to end liquidity. Not a signal about inflation, a signal about a loss of Fed liquidity coming. This kicked off a big scramble to get out and not be the bond bagholder when the Fed printer is turned off. This naturally begs the question, what about the stock market? The S&P was down 1.9%, hardly an epic week. What's going on here? Hate to say it, but the stock market is not a leading indicator among financial markets. So if the bond market is having epic convulsions in the wake of the Fed printer getting turned off, do not take solace that the stock market, quote-unquote, doesn't get it. This is how financial markets turn.

Starting point is 00:15:26 The stock market often stays too long and turns last. So clearly, in Bianco's point of view, the bond market is signaling hard that there is a shift happening, a fundamental shift in the way that the Fed is playing in markets. And it's not about inflation. It's about liquidity. Now, what are the mitigating factors that could change the picture that's starting to emerge? Well, the first is that inflation really might be. transitory in the way the Fed argued through most of last year, and by the way, still seems to

Starting point is 00:15:56 believe. This is the argument that inflation is caused largely by supply chain disruptions that will eventually work themselves out. The problem is they just have less confidence about the timing on when those disruptions will unwind, and the political chickens have come home to roost in the meantime. Still, it's not impossible, as was articulated in one of the threads I just read, that inflation estimates continuously being lower than the market's expectations could shift some of this sentiment. The second way this all might not come to pass, however, has to do with political narrative shifts. Bianco, in a separate tweet when someone asked, couldn't they just keep the printers on, responded, the difference now is inflation. If it's all

Starting point is 00:16:35 talk, that means they are cool with 7% inflation. See the latest Biden approval ratings. Nose diving because of inflation. Keep printing, allow inflation, wipe out the Democratic. Democrats in November. And this is where things get extra interesting. Biden gave a speech at the end of last week that showed that they are going to engage with this particular issue. He said, at this moment as a country, we face an important choice. Do we take the steps to create an economy with strong sustainable growth with higher wages and more opportunity for all Americans? Or do we settle for an economy that wasn't working for our middle class even before the pandemic began? An economy that has delivered sluggish growth, stagnant wages, limited opportunities.

Starting point is 00:17:15 I'm not an economist, but I've been doing this a long time. Here's a way to look at it. If car prices are too high right now, there are two solutions. You increase the supply of cars by making more of them, or you reduce demand for cars by making Americans poorer. That's the choice. Believe it or not, there's a lot of people in the second camp. You hear them complain that wages are rising too fast

Starting point is 00:17:35 among middle class and working class people who've endured decades of stalled incomes. Their view of the economy says the only solution to our current and future challenges is to make the working families that are the backbone of our country poorer, or keep them in the state they were in. It's a pessimistic vision, and I reject it. I reject the idea that we should somehow punish people because they finally have a little more breathing room.

Starting point is 00:17:56 America doesn't need to settle for less. We have an economy that has the capacity to generate more growth, more jobs, and more opportunity for all Americans. Joe Wisenthal tweeted and got at the heart of this, saying, very interesting section from Biden's speech. He notes that car prices are too high and that there's two solutions. One, invest more to bring more capacity to the sector, or two, make everyone poor so demand goes down. Now, what Joe is getting at here is that there is a clear, explicit rejection of austerity as a method to fight inflation.

Starting point is 00:18:25 In Biden's speech, a rejection, in fact, even of potentially the idea that inflation is what we should be focused on. A follow-up exchange on Joe's thread between David and Alfato, a senior VP at the St. Louis Fed, and a number of others, shows the different sides of this argument, which gets into this asset price inflation conversation. Endelphoto writes, deflating elevated asset prices won't make everyone poor, though. Only those who are holding net long positions in those assets. Large segment of society has no direct stake in these assets. Joe responds, will deflating elevated asset prices make use cars cheaper?

Starting point is 00:19:01 Endelthotto writes, yes, I believe so. I can't imagine how it would make them more expensive, do you? Skanda Amernat, the Executive Directorate Employer America, responds, Reh can't imagine, cost of capital, inventory, financing and capital budgeting are also sensitive to the same underlying mechanism. Ultimate relevance depends on context and shouldn't be overgeneralized, but more likely to be relevant for something capital-intensive like cars. The point here is that as soon as you get into the details, we are in the world of three

Starting point is 00:19:28 smart people are going to have four smart opinions between them, and nobody really knows. But I think the most salient thing here is that Biden seems to be signaling that he's not going to accept austerity as a mechanism to fight inflation as the political narrative. for Dems going into the midterms. So let's try to sum up. We've got what seems to be a seed change in the Fed. The bond market is certainly betting on it. We've got some debate about the implications for digital assets. And finally, and perhaps most significantly, we have the President of the United States waiting into the narrative discussion, kicking off a new phase for the battle in how we should view inflation, austerity, and monetary and fiscal policy. So what's the next part of this story?

Starting point is 00:20:07 Well, as Alex Krueger pointed out, there's a CPI print coming this Wednesday. Expectations currently suggest it to come in around 7.1%. If we go above or below those number could have a pretty big impact on the next phase in this narrative battle. For now, I want to say thank you to my sponsors, nexo.io, Abra and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - The Macro Battle That Will Shape Crypto Markets This Year

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